Accounting coding systems

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Accounting coding systems

Need for an accounting coding system

Imagine if the tax authorities were to maintain all the records of taxpayers according to their names.

There would be hundreds of thousands of taxpayers with the same name.

How can this problem be solved?

Such problems can be solved by using coding systems. 

A busy organisation has many ledger accounts inside and outside of the organisation, using their names or simply numbering them 1,2,3 would be very difficult. 

Therefore, the ledger accounts, inventory items, employees on the payroll etc will all require unique codes. 

Codes could be used to identify the main categories of the ledger accounts. 

Organisations could perhaps start with the five main categories of ledger accounts and then further subdivide them into minor categories and so on.

Codes could also be used to show the location of items within the organisation, e.g. sales department, purchasing department, wages department, factory locations etc. Therefore, expenses like depreciation could easily be charged to the department which uses them.

The following structure illustrates how a coding system may be used for a nominal ledger in a large organisation.

A six-digit code is used: the first digit represents the functional analysis; digits 2 and 3 represent the cost centre (i.e. the department); and digits 4–6 represent the type of expense involved. An example code could be 110202, which represents unskilled-labour wage cost incurred in the machining cost centre of the production function.

Functional analysis Cost centre (within production) Nominal ledger expense analysis
1 Production 10 Machining 100 Raw material X
2 Sales 11 Assembly 101 Raw material Y
3 Administration 12 Finishing 201 Skilled-labour wages
202 Unskilled-labour wages
203 Salaries
301 Rent
601 Postage

Characteristics of codes

It is generally accepted that codes should have certain characteristics.

  • Unique
    In order to avoid ambiguity, each item must have only one possible code.

  • Useful
    There is no point in using a code if there is no benefit from its use. 

    The users of the system have to learn the code so that it may be both applied and understood.

  • Compact
    The shorter the code the easier it is to learn and the likelihood of mistakes and confusion is reduced. 

    Thus, a code should be as short and compact as possible.

  • Meaningful
    The code should be made meaningful by connecting the characters of the code in some way to the item that the code represents so that it is more easily remembered and understood.

  • Self-checking
    The biggest problem with the use of codes is that users of the codes remember them incorrectly. 

    To ensure that the information the system provides is of value, each of the codes used must be validated. 

    If a numeric code is used it should be designed in such a way that it is self-checking. 

    This helps in identifying coding mistakes and avoids the production of incorrect information.

  • Expandable
    When designing a coding system it is important to consider the requirements of the organisation in the future. 

    The design of accounting systems often involves a large amount of time and this is then followed by a period when the users are learning the system. 

    If the code is not expandable, then the system needs to be changed sooner rather than later. 

    This is costly in design time and would cause difficulties because the users of the system would have to learn the new system.

  • Standard size
    If codes are of varying size, different users may write the same code differently. 

    For example, if a part of a coding system comprises up to four characters, then the three-digit code XY1 could be written in a number of ways, with spaces and dashes in different places. 

    In such cases, instead of using XY1, using XY01 would prevent it from being written in a number of ways.

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